Treasury to detail borrowing needs

Return to budget deficits leaves buybacks in question

By

RachelKoning

WASHINGTON (CBS.MW) -- The next chapter in the government's bond buyback program unfolds next week as an expected return to budget deficits has complicated federal debt management.

Most analysts don't look for an immediate end to the program, which has market-moving implications regardless of what the government decides, but they suggest a deteriorating budget scenario for the next few years could eventually suspend its use.

The Treasury will announce the details of the nation's financing needs for coming months at the regularly scheduled briefing it holds each quarter; borrowing needs will be detailed in a press release Monday, while any policy changes are expected to be announced Wednesday morning at a media-only press conference newly designed to avoid the leaks that resulted at last quarter's announcement.

At issue for investors: How the economic slowdown's reduction of tax collections will affect the government's coffers and whether Treasury's program to reclaim part of the near $3 trillion in outstanding marketable debt through direct buybacks will continue for much longer or as aggressively as it has been carried out.

From black to red ink

Not only has the first down business cycle in a decade wreaked havoc in government budget offices, but the tragedy of Sept. 11 and the unplanned but also necessary emergency spending that resulted from the attacks now has to be accounted for. Unplanned defense spending also kicked in.

The White House has predicted an $80 billion deficit for the current fiscal year that began on Oct. 1. The Congressional Budget Office expects a comparable shortfall. Under the assumption that growth snaps back in 2003, the budget would return to surplus in fiscal year 2004, both the administration and the CBO say.

"It's a close call, but we think Treasury will commit to repurchasing a small amount of debt over the next few months, targeting April for the purchases," said Chris Wiegand, an analyst at Citigroup's Salomon Smith Barney.

The buybacks are important to the marketplace because they signal a wholesale effort to reduce the nation's debt load.

Generally, the buybacks, which have so far targeted longer-dated securities because their interest payments are most expensive for Uncle Sam, are bullish for the market. Fewer supplies of securities improve the worth of the remaining securities in circulation and even those to come down the pipeline.

Wiegand recognizes that Treasury officials have a challenge at hand.

"February-March cash flow presents a rather high hurdle to buybacks. Both months are among the weakest of the year in terms of budget flows. And, given current labor market conditions, that ought to especially be the case this year," he said.

Wiegand predicts Treasury likely will borrow approximately $70 billion during the first three months of the year, a forecast in line with market consensus. As was the case in the fourth-quarter, borrowing is expected to be concentrated at the front-end of the curve.

But eliminating the more expensive long-term debt by funding the buybacks with proceeds from auctions of short-term debt could still present a problem to the government in wake of unexpected defense and emergency spending.

The government believes it will bump up against the $5.95 billion debt ceiling it must abide by in March and is seeking an extension from Congress.

"While it sounds strange, buybacks, in reducing the stock of marketable debt, actually raise the amount of total debt outstanding," Wiegand said.

He explained that government accounting rules mandate that the interest and inflation premium Treasury pays to repurchase bonds be counted against the total value of debt outstanding, effectively forcing Treasury to issue an average $1.3 billion in new non-marketable paper for every $1 billion removed from the market.

Although April tax collections will give the government some flexibility in coming months, those collections will be the thinnest they've been in several years thanks to the recession.

Still, the extra cash could keep the buyback program alive for now, most analysts said.

But at least one analyst questions the approach the government is taking in focusing its debt issuance on shorter-maturity rather than longer-maturity debt.

"The Treasury is grappling with a rise in financing needs but remains mired in a risky strategy of financing a large portion of the nation' s debt with 2-year notes and T-bills," said Tony Crescenzi, bond market analyst with Miller Tabak & Co.

"This risky strategy forces the Treasury to roll over debt frequently and fails to lock in low long-term interest rates," he said. "The Treasury's strategy is akin to homeowners choosing 1-year adjustable mortgages when 30-year mortgage rates are near all-time lows."

The government's argument has been that over the long run, a shorter maturity spectrum saves them -- the taxpayers actually -- interest costs.

Rule change

Meanwhile, Treasury has in place plans it believes will remedy the risk of a leak at the upcoming refunding briefing.

At the last refunding, news of the elimination of issuance of new 30-year bonds was given by consultant Pete Davis, who attended the briefing, to some clients ahead of the pre-set embargo time. That breach launched an internal Treasury investigation and an inquiry by the Securities and Exchange Commission to make sure the information wasn't used at an advantage over other investors.

Word of the bond's elimination set off one of the largest single-day rallies in the bond market's history.

This time, only credentialed media signed into the Treasury through the public affairs department will be allowed to receive the data early, to be held until embargoed transmission under a "lock-up" procedure used to issue government data and Fed interest-rate decisions.

After the release, Treasury officials will brief the media to supply any additional information on policy changes or the borrowing decisions made by the Treasury.

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